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Tata Capital > Blog > Wealth Services > Mutual fund portfolio overlap: What is it and how to avoid it?

Wealth Services

Mutual fund portfolio overlap: What is it and how to avoid it?

Mutual fund portfolio overlap: What is it and how to avoid it?

Looking for a new mutual fund scheme to invest in? Beware of portfolio overlap!

All investors want to maximise their returns and minimise risk. Diversifying your portfolio by investing in multiple mutual fund schemes is an effective way to achieve this. To ensure that your portfolio is well-diversified, it is important for an investor  to know about mutual fund portfolio overlapping and how one can avoid it. So, keep reading to learn more about mutual fund portfolio overlap and some tips to steer clear of this situation.

What is mutual fund portfolio overlap?

Mutual fund portfolio overlap happens when you purchase units of multiple schemes where the underlying portfolio holdings are very similar. This may be because the schemes have similar investment objectives or may track the same index.

What does mutual fund portfolio overlap mean for an investor? Suppose you own units across several mutual funds that hold similar investments. Ifall of them have invested heavily in the technology sector,this can result in an unintended concentration in tech stocks and nullify your diversification efforts.

This increases the overall risk of your portfolio lest the technology sector should plummet!

Apart from concentration risks, there are more subtle correlation risks involved. Different types of investments (such as bonds, stocks, gold, real estate, cryptocurrency, and commodities) have different relationships to each other. Some may have a strong correlation, which means that if one investment type is affected negatively, it can have a ripple effect on the rest of your portfolio.

How to avoid portfolio overlap?

Here are three ways to avoid portfolio overlap:

#1 Research the holdings of each mutual fund scheme

Before you invest in a mutual fund, go through its top holdings, sector-wise weightage, and exposure. Once you understand the underlying investments of each fund, you can safely avoid spreading your corpus across funds with similar holdings.

#2 Invest in index funds

Index funds are designed to replicate the performance of a market index such as NIFTY or SENSEX. By investing in index funds, you gain exposure to a diversified portfolio of small-cap, mid-cap and large-cap stocks. These stocks are selected by fund managers to ensure proper diversification with minimal overlap.

#3 Use online portfolio management tools

Today, there are several convenient mobile apps and online tools that can help you stay on top of your portfolio. Using these tools, one can analyse a fund’s portfolio thoroughly before investing in it. You can also compare new funds with your existing holdings, identify areas of concentration and avoid overlapping of funds

What to do if you identify an overlap in your portfolio?

If you notice that you have inadvertently invested in mutual fund schemes that are too similar, don’t worry. You can either consolidate your holdings by selling some units of the funds that have significant overlap or you can reinvest the proceeds in funds with different holdings. Another excellent solution is to diversify across asset classes, such as stocks, bonds and gold.

In summary

Avoiding mutual fund portfolio overlap helps to maintain financial health by minimising overall concentration and correlation risks. By regularly monitoring your portfolio and duly analysing and comparing new mutual funds, you can avoid being stuck and can create a well-diversified portfolio instead.

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